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Monday, August 8, 2016

As of this post, we have covered most of Article1 and
Article 3, and close to half of Article 2.
I am very pleased with the growing views on the blog, and have received
some encouraging emails from readers. As
I stated when the blog first opened, the primary goal is to teach the basic
meaning of the text of the UCC. Periodically, as in the last post, I find a
case which requires discussion, but even in that context, the primary focus is
on the meaning of the text and how it fits in the overall flow of the UCC.

As a law
professor, I felt it important to begin each class with a review, and
periodically, and I feel the same need as to the blog, not just for the
readers, but for myself as well. With
the large number of new readers, and a lot of substantive text behind us, I
wanted to do a brief review of Article 1 and its impact on the UCC. This is
done in the hope that whenever you may encounter a UCC transaction at the
drafting, litigation, or intermediate stage, you will be certain to process the
transaction through Article1 in addition to the substantive Articles activated.

I believe that Article 1 is the most important Article
under the Uniform Commercial Code for two primary reasons. First, Article 1 applies to all transactions under the Code per
Section 1-102.Therefore, regardless of where you are in the Code, Article
1 has impact, and the impact can be dramatic. The substantive Articles deal with the subject matter
with the purview of each Article, however, the content of these Articles only
presents part of the story, for in order to truly understand the meaning of any
of the substantive provisions of the UCC, it is essential to have a thorough
understanding of Article 1.

Second, Article 1 contains some of
the most powerful and impactful provisions of the Code, provisions which bring
light and special meaning to the language of a contract; create remarkable
drafting opportunities; and contain the fundamental policies upon which the UCC
is drafted:

(a) The Uniform Commercial Code must be liberally
construed and applied to promote its underlying purposes and policies,
which are: (1) to simplify, clarify, and modernize the law governing commercial
transactions; (2) to permit the continued expansion of commercial practices
through custom, usage, and agreement of the parties; and (3) to make uniform the law among the
various jurisdictions. [Emphasis Added]

As stated in Section 1-103(a)(1)(2)(3), the drafters of the Code direct that the UCC
be ‘liberally construed and applied’ to promote these policies. An attorney who
lines up legal arguments with an appropriate policy, coupled with the
directives for liberal construction and application, has a great advantage in
guiding the court to the desired result.

In addition to the stated policies,
Section 1-103 contains one of the most powerful and important provisions of the
Uniform Commercial Code:

Unless displaced by the particular provisions of the Uniform Commercial Code, the principles of law and equity, including the
law merchant and the law relative to capacity to contract,
principal and agent, estoppel, fraud, misrepresentation, duress, coercion,
mistake, bankruptcy, and other validating or invalidating cause supplement its
provisions. Section 1-103(b)

The
net effect of Section 1-103(b) is to incorporate all ‘principles of law and
equity’ which exist, ‘unless displaced by the particular provisions of the
Uniform Commercial Code.' So, if the
Code doesn’t knock it out via a ‘particular provision’ the whole body of law
involved will supplement the Uniform Commercial Code provisions. It doesn’t get more powerful than that.

A simple review of the supplemental principals of law
stated illustrates the massive content available to attorneys who are involved
in UCC transactions. The general law of
contracts, agency, estoppel, misrepresentation and fraud often are often intertwined
in commercial transactions.
Understanding the applicability of any of these supplemental principles,
and how to creatively utilize them gives an enormous advantage to someone so
armed.

The impact of Article 1 is dramatically illustrated in
the case of In Re Invenux, Inc., 298 B.R. 442, 51 UCC Rep Serv
2d (Bkrtcy. D. Colo. 2003). The trustee in bankruptcy was
attacking the validity of a security agreement on the grounds that it did not
adequately describe collateral as required by Section 9-203 The security
agreement in question was very detailed in its composition, but did not include
stock that was purportedly to be included.
Defendant’s position was that the contract—i.e.—the security agreement,
was reformed between the original debtor and the secured party and therefore,
stock was incorporated into the security agreement.

The question before the court was very significant for
two reasons. First, if the court did not
find a reformation, the security agreement would have been invalid and the security
interest unenforceable. Second, if the
court found a reformation, as it did, the result would in effect be concluding
that the supplemental principles contained in Section 1-103(b) can override the
substantive provisions of another Article.
Considering the incredibly broad scope of Section 1-103(b), the
implications are enormous. In re
Inveneux is not an aberration as regards the impact of Section 1-103(b)
on the substantive articles of the Code, but illustrative of the powerful
impact that section can have under the UCC.

I review Section 1-103(b) in connection with every
case I review under the Code.
Regrettably, a very large number of commercial transactions involve
fraud and misrepresentation. It may also
be that under the law of a particular substantive Article a result may appear
to be inequitable. Section 1-103(b) supplements the totality of the Code with
the law of equity. Even if one does not
win on such a theory, it forces the opposition to respond and creates doubt.

Another reason Article 1 is so
important is that it contains critical definitions which are applicable
throughout the Code. There are two
definitions which are so important and powerful under the Code that they must
be highlighted. These are the
definitions of ‘contract’ and ‘agreement.’

To get a full picture of the concept
of contracts under the UCC, one must move beyond the instinctive reactions that
most of us have when we hear the word ‘contracts’ in connection with the Code,
namely, Sales contracts. The application
of the word contract under the UCC embodies much more. It is not an
exaggeration to say that it is the most important definition in the Code,
certainly from an operative standpoint.
Breach of contract is the essence of all lawsuits under the UCC. So in viewing the UCC and the word
‘contract,' one should envision the concept as one which permeates the
UCC. By way of illustration, contracts
exist under the Code between: buyers and sellers [Article 2]; lessors and
lessees [Article 2A]; makers and payees [Article3]; banks and customers [Article
4]; applicant and issuer [Article 5]; issuer and bailor [Article 7] debtor and
secured party [Article 9].

The foregoing contractual
relationships are illustrative, not by any means exclusive. In an earlier post, I suggested the benefits
of a systematic approach to all UCC problems.
This creates a consistency of methodology, and the brain will adjust
accordingly. Once the facts are
thoroughly understood and diagrammed, I suggest a very detailed analysis of
contract and agreement. As you will see shortly, the elements of agreement
dramatically impact the bottom line meaning of the contract. Once the analysis
of ‘contract’ and ‘agreement’ are in place, Section 103(b) should be reviewed.

The formal definition of contract is
found under Section 1-201(b)(12):

“Contract means… the total legal obligation that results from
the parties' agreement as determined by the Uniform Commercial Code as
supplemented by any other applicable laws."

It is clear from the foregoing definition, that in order to
determine the elements of a particular contract, one must first ascertain the
parties’ agreement, defined
as follows:

“Agreement” means
the bargain of the parties in fact as found in their language or inferred from
other circumstances, including course of performance,course of dealingor usage of trade as provided in
Section 1-303. Section 1-201(b)(3)

The language of the parties may be explicit, but what it is
fascinating, is that what might appear to be very clear and precise language,
or no language, can be literally transformed by the application of course of
performance, course of dealing or usage of trade. Each is discussed in Section
1-303(a)(b)(c) respectively.

Course of performance
requires, among other things, a contract with multiple occasions for
performance and course of dealing requires previous transactions between the
parties. Neither may be present in any
given situation. Amidst this uncertainty
there is one thing that can almost always be counted on to supply valuable
information to any agreement under the Uniform Commercial Code:Trade Usage. Commercial transactions take place
within the context of an existing industry, 99 plus per cent of the time. Within that industry, there is a
manner of business so customary and fundamental to the industry, that it
becomes part of the agreement between the parties, regardless of whether or not
it is even discussed.

Trade usage is defined
under Section 1-303(a) as follows:

A "usage of trade" is any practice or method of dealing
having such regularity of observance in a place, vocation, or trade as to
justify an expectation that it will be observed with respect to the transaction
in question….

The impact that trade
usage can have in a case is dramatically illustrated in the case of In Re: Cotton Yard Antitrust Litigation,505 F.3d274 (4thCir.,
2007).At issue was whether or
not plaintiff purchasers of cotton and poly-cotton yarn were required to submit
their antitrust case to arbitration via an arbitration provision which,
according to defendants, was part of the contract as a result of the regular
and customary use of arbitration in the textile industry as a means of
resolving disputes.

At issue on appeal was
whether the district court’s ruling which excluded

arbitration for the antitrust claim was correct. The court of
Appeals reversed the District Court on the arbitration ruling. After discussing case law which
recognized arbitration as the standard manner of resolving disputes in the
industry, the court held that the arbitration provision was automatically part
of the contract between the parties as a result of arbitration being a trade
usage in the textile industry. This
was true regardless of the fact that it was never formally agreed to by the
purchasers. The court
further found that a party’s knowledge of a trade usage, or lack thereof, is
irrelevant, a result which is clearly consistent with the text of the statute.

There are over
86,000 trade associations in the United States, each with its own rules and
general codes of conduct. I recently
consulted on a case which had a trade association of six members, but
nevertheless had clear cut rules on what was supposed to happen in the event
goods supplied by members of the association turned out to be defective. While these rules may not always be
controlling, they are always relevant.

Another very important
provision under Article 1 is Section 1-302, the Code’s freedom of contract
provision. Subsection (a) allows parties to change the ‘effect’ of provisions
under the UCC, while subsection (b)
states that ‘the obligations of good faith, diligence, reasonableness and care
may not be disclaimed.' However, the
section goes on to state ‘The parties, by agreement, may determine the
standards by which the performance of those obligations is to be measured if
those standards are not manifestly unreasonable.'

By setting standards for the
performance of the items noted, the parties dramatically change the inquiry
should the matter end up in litigation.
In a case where no standards are set, the court and/or jury will
determine whether or not a particular standard has been met. If standards are
set, the inquiry is substantially different.
In this instance, the inquiry is: Were the standards met? Are the standards set ‘manifestly
unreasonable?' If met, and not manifestly unreasonable, they will hold up. The latter scenario gives the parties much
greater control as to the outcome in court.

One of the stated
underlying policies of the UCC is ‘uniformity of law among the various
jurisdictions’ Section 1-103(a)(3). The
provision has been interpreted by many courts to include decisions from other
states in a local jurisdiction.
Therefore, an attorney has the case decisions of 50 states as part of
his or her arsenal. Many attorneys
simply do not know about Section 1-103(a)(3) and are a corresponding
disadvantage in working with the Uniform Commercial Code.

Another critically
important provision under Article 1 is Section 1-304 which states:

Every contract or duty within the Uniform Commercial Code imposes
an obligation of good faith in its performance and enforcement.

Good faith is defined as:

…honesty in fact and the observance of reasonable commercial
standards of fair dealing.

Breach of the duty of good faith can have serious
consequences. Although the comments to Section 1-304 state that no independent
cause of action can be brought for a breach of the duty of good faith, there is
case law to the contrary. In fact, in
the case of InFirst Nat. Bank in Libby v. Twombly,
213 Mont. 66, 689 P.2d 1226 (Mont. 1984), the court stated:

"When the duty to exercise good faith is imposed by law
rather than the contract itself…the
breach of that duty is tortious. Therefore, punitive damages are
recoverable if the Bank's conduct is sufficiently culpable."First National Bankin Libbyat 1230.

Any
litigant who can persuade the court to entertain a claim for punitive damages
has enormous leverage.

It is important to note that while
the definition of ‘good faith’ quoted above is adopted in the majority of
jurisdictions, it has not been adopted in all of them. For example, New York,
Illinois and Missouri have not adopted the amended definition of good faith.
The minority definition of good faith is ‘honesty in fact in the conduct or
transaction’ concerned. There is no
requirement for commercial reasonableness, itself a matter of interesting
interpretation. As the comments to
Section 1-304 state, the conduct being reviewed is not the commercial
reasonableness of the actual conduct in the transaction, but the commercial
‘fairness’ of the conduct.

In this regard, it is important to
remember Section 1-301 which allows parties to transaction under the UCC to
choose the law of any state as long as that state has a ‘reasonable relation’
to the transaction in question.
Individuals involved in multistate transactions should always check the
law of the other jurisdiction prior to any drafting so that the law most
favorable to the client can be drafted into the contract. Although the Uniform Commercial Code is
designed to be ‘uniform,' it is processed through each state legislature before
adoption. Often changes are made and
sometimes they are significant. In
addition, the Code gives various alternatives to the states to adopt. Section 2-318 dealing with third party
beneficiaries of warranties offers a dramatic example and potential impact of
the differences between the provisions which may be enacted in a particular
states.

The forgoing sections are
illustrative of the impact that Article 1 can have under the Uniform Commercial
Code. Most of the provisions of Article
1 are covered in earlier posts for any readers who want to review the
same. The critical point however, is
that if you are involved in UCC transactions—whether at the drafting stage, or
litigation—it is essential to have a solid working knowledge of Article 1. This will give you an enormous advantage in
all dealings which you encounter under the UCC.

Thursday, July 21, 2016

As of this post, we have seen the
basic rule of Section 2-204(3) in operation multiple times within the text of
the Code. By way of review, that section states:

Even though one or
more terms are left open acontract for saledoes not fail for
indefiniteness if the parties have intended to make acontract and there is a
reasonably certain basis for giving an appropriate remedy.

In
the previous post we looked at the absence of a price term in a contract, and
saw that per Section 2-305, the parties can create an enforceable contract
without a price in place. That, like
the general rule of Section 2-204(3), requires the intent of the parties to
enter into such an agreement.

We now look at a situation in which
no specific quantity need be stated in order to have an enforceable
contract. In this instance, the quantity
term is supplied by the ‘requirements of the buyer’ or ‘the output of the
seller’. This situation is governed by
Section 2-306(1):

(1) A term which measures the quantity by
the output of theselleror the requirements of thebuyermeans such actual output or requirements as may occur ingood faith, except that no
quantity unreasonably disproportionate to any stated estimate or in the absence
of a stated estimate to any normal or otherwise comparable prior output or
requirements may be tendered or demanded.

Although
the good faith requirement for output and requirements contracts is mandated by
Section 1-304, Section 2-306(1) explicitly states the good faith requirement in
output and requirements contracts.

The good faith component has
parameters placed upon it, in that no output or requirement may ‘be
unreasonably disproportionate to any stated estimate’. In the absence of any stated estimate, no
output or requirement may be tendered or demanded which is not ‘normal or
otherwise comparable prior output or requirements’.

It is clear from the text that if no quantity is
stated the seller’s output would be comprised of all units produced by the
seller. Similarly, if no specific amount
of requirements are stated, the buyer would be able to request all units to
fulfill its needs. Both of course are
subject to the limiting language of ‘normal or otherwise comparable output or
requirements’, and the good faith requirement of ‘honesty in fact and the
observance of reasonable commercial standards of fair dealing in the trade’.

A question appears to have arisen as
to what happens when the buyer provides a stated estimate and then chooses not
to purchase any units. Does the seller have any rights in that situation? A reading of the text of Section 2-306(1)
would appear to allow the seller to tender units to the buyer as long as the
amount tendered was not ‘unreasonably disproportionate’ to the stated
estimate. That however is not the result
reached in a 7th Circuit case that posed this precise question.

Empire
Gas Corp. v American Bakeries Co.840 F.2d 1333 (7th Cir., 1988) Empire Gas was a retail distributor of
propane, and a provider of conversion units which convert gas engines to
propane engines. The major source of
profit for Empire was in the contract to purchase propane from Empire which
accompanied the sale of the conversion units
During the contract period in question, gasoline prices had risen
dramatically resulting in American Bakeries’ decision to convert to propane and
its resulting contract with Empire. The first contract drafted by Empire was
rejected by American, but the subsequent contract was accepted and executed,
which required American to purchase“approximately three thousand (3,000) [conversion] units, more
or less depending upon requirements of Buyer”.

In discussing Section 2-306, the court
posed the question of whether or not a buyer who makes a ‘stated estimate’ of
its anticipated needs is actually bound by that estimate as stated in the
contract when a buyer decides to purchase no units, or whether that estimate,
embodied in a signed writing, is irrelevant and unenforceable. Judge Posner stated the question as follows:

So we must decide whether the
proviso should be read literally when the buyer is demanding less rather than
more than the stated estimate.

The
court discussed the applicability of the ‘stated estimate’ language to a buyer
who orders more than a stated estimate. The court reasoned that without the
limiting language, a buyer could order significantly more goods when the market
was favorable. In discussing the issue, the court noted that the statute and
Official Comment 3’ points to symmetrical treatment of the overdemanding and
underdemanding cases.’

Despite the clear language of the
statute and comment 3, the Court concluded that the stated estimate of the
buyer was of no legal significance when the buyer chose to purchase no units. In
reaching its conclusion, the court noted case law and respected commentary
which stands for the proposition that a buyer can reduce its requirements to
zero as long as it does so in good faith.
Such a reading is consistent with the statute when a buyer has agreed to
buy all of its requirements from a particular seller. Clearly, if it turns out that there are no
requirements, and that this is the result of a good faith decision by the
buyer, there is no breach.

I do not however, agree with the conclusion
that a stated estimate by a buyer is of no legal significance when the buyer
does not purchase any goods under the requirements contract. First, and foremost, such a result is in
conflict with the clear language of the statute. It is clear from the statute that a seller in
such a situation has the right to tender a quantity as long as the quantity is
not ‘unreasonably disproportionate to any stated estimate’.

The purpose of the ‘stated estimate’
is easy to grasp. It allows a seller of
goods to make preparations for the buyer while being able to fulfill other
orders. If, as in Empire Gas, seller knows that its buyer is committed to
purchasing a certain number of units, it can procure materials to accommodate
that order. Additional production may
also be required. The stated estimate
allows the seller to prepare. I
emphasize that the buyer can avoid this result by contracting for ‘all
requirements’, rather than a stated estimate.

As Judge Posner notes, the comments
clearly indicate the drafters’ intent that the "the agreed estimate is to be regarded as a center
around which the parties intend the variation to occur."A fair read of that language leads to the
conclusion that the drafters considered the ‘stated estimate’ to have legal
significance. Moreover, there is nothing
in the text or the comments which supports limiting the applicability to over
purchases by a buyer as opposed to no purchases by the buyer.

I emphasize again that the case involving the ‘stated
estimate’ is different than a pure requirements contract. If a contract is for ‘all requirements’ of a
buyer, and if the buyer in good faith has no requirements, the buyer is not
liable. On the other hand when, as in this case, the parties negotiated a
contract with a stated estimate of requirements under that contract, I believe
that the buyer is bound by that estimate within the variations permitted by the
Code. The buyer could easily have
limited exposure by simply contracting for ‘all requirements’.

Finally, of great significance is the recognition
throughout the Code of freedom of contract as an affirmative principle of the
Code as embodied in Section 1-302(a).
Moreover, recognizing the agreement of the parties is an underlying
principle upon which the Code was drafted per Section 1-103(a)(2). The parties in Empire agreed that American Bakeries would purchase approximately
3,000 units. This term was negotiated by
both parties. It is my opinion that the
‘stated estimate’, agreed to by the parties, has legal significance and is
binding.

Wednesday, June 29, 2016

The Article 2 policy, to
facilitate the deal, is nowhere more evident than Section 2-305, for that
section allows a contract to be formed regardless of whether or not the parties
have agreed on a price. This is a radical departure from Pre-Code law. This
rule is contained in the first sentence of Section 2-305 which states as
follows:

‘The parties if they so intend
can conclude a contract for
saleeven though the price is not settled….’

On it's face, this would seem to conflict with
Section 2-204(3) which also facilitates the formation of a contract where the
parties intend to form a contract, provided there is a ‘reasonably certain
basis for giving an appropriate remedy.'Price is definitely essential in providing an ‘appropriate remedy.' This
is provided in the open price situation as follows:

In such a case the price is a reasonable price at
the time for delivery if

(a)
nothing is said as to price; or

(b)
the price is left to be agreed by the parties and they fail to agree; or

(c) the
price is to be fixed in terms of some agreed market or other standard as set or
recorded by a third person or agency and it is not so set or recorded.

There are a couple of things to be noted in Section
2-305(1).First, there must be requisite
intent by both parties to the contract for the open price term to be valid.Second, it is important to remember the full
import of the definition of ‘agreement’ when trying to ascertain whether the
parties ‘agreed’ to an open price term.Such an agreement can arise by way of course of performance, course of
dealing and usage of trade.

There are situations where the parties agree that a
seller or buyer must set a price.In
such a situation, the price must be fixed in good faith.

Once again, we see the concept of good faith
figuring into the equation. If the parties are merchants, this requires
‘honesty in fact and the observance of reasonable commercial standards of fair
dealing in the trade.'Remember that
this definition, unlike the definition of ‘good faith’ in Article 1 ties
‘reasonable commercial standards of fair dealing’ to whatever trade is
involved.

One
might have difficulty imagining an ongoing business practice of entering into
open price contracts.However, when
viewed in the context of a fluctuating market, an open price term makes perfect
sense.The petroleum industry offers an
excellent example of an industry that has an ongoing practice of open pricing.Litigation within that industry demonstrates
some points raised in earlier posts.For
example, is the good faith standard based upon a subjective analysis or an
objective analysis.In fact, inMathis v. Exxon Corp., 302 F.3d 448, 454-57 (5th Cir.2002), the Fifth Circuit
interpreted Texas law on the question to involve both subjective and objective
standard.

Mathis involved a claim by Exxon
dealers in Texas which was predicated on alleged bad faith pricing by Exxon regarding the cost of gasoline to its dealers. The dealers alleged that Exxon was
attempting to drive them out of business by overcharging for the gasoline which
the dealers were required to purchase under their agreement with Exxon. Under
the terms of the agreement, Exxon was permitted to set the price for the
gasoline to be purchased by the Exxon dealers. The court noted:

Texas law, which
tracks the Uniform Commercial Code, implies a good faith component in any
contract with an open price term. Specifically,

[t]he parties if they so intend can conclude a contract for sale
even though the price is not settled. In such a case the price is a
reasonable price at the time of delivery. A price to be fixed by the seller or by the buyer means a price for him to fix
in good faith.

Exxon
contended that its pricing was proper inasmuch the price charged was within the
range of its competitors pricing and therefore established the ‘commercial
reasonableness’ requirement of good faith. The dealers’ contention was that
even if the price set was within the range stated by Exxon, good faith required
more. In essence, the dealers stated that if the ultimate purpose of Exxon was
to drive the franchises out of business, this would violate the ‘honesty in
fact’ portion of the good faith requirement.

The Court discussed comment 3 to
Section 2-305 in great detail, noting that in a ‘normal’ case the type of
standard pricing used by Exxon would have satisfied the good faith
requirement.However, the court went on
to state that a lack of subjective good faith, such as the one alleged by the
dealers, would take the pricing of Exxon into the realm of bad faith.Accordingly, the judgment of the district
court in favor of the dealers was affirmed.

In Tom-Lin Enterprises, Inc. v. Sunoco, Inc. (R&M), 349 F.3d 277 (6th Cir. 2003)
the court concluded that Ohio law required the analysis of the question of good
faith to be limited to the objective standard:

Thus, under Ohio law, to show that a
merchant-seller lacks good faith in fixing a price pursuant to a contract with
an open price term, it must be shown that the price was not fixed in a
commercially reasonable manner and, moreover, that the pricing was commercially
unjustifiable. These are two distinct issues, and both involve an objective
analysis of the merchant-seller's conduct. at 280 [Emphasis the Court’s]

The Tom-Lin case is brought to your attention for
several reasons.First, to illustrate
the differences between the interpretation of the good faith requirement under
Section 2-305; second to remind you of the importance of understanding key UCC
provisions of any state in which your client might be doing business.To the extent the transactions involve
multiple jurisdictions, a party can draft the law of the favorable jurisdiction
to control, provided the requisite contact with the chosen state exists.As the Mathis and Tom-Lin cases indicate, the
differences can have a dramatic impact on the outcome.

Saturday, May 21, 2016

As of this post,
we have looked at some of the basic concepts in the formation of a contract
under Article 2 including: the Statute of Frauds under Section 2-201; the
importance of the distinction between a merchant and non merchant under Article
2; battle of the forms under Section 2-207; parol evidence under Section 2-202;
recovery of attorneys’ fees as consequential damages under Section 2-607(5)(a);
right to adequate assurance of performance under Section 2-609, and the failure
of presupposed conditions under Section 2-615.

All of this is
supplemented with all of the posts on Article 1 starting with the Purposes and
Policies of the UCC as stated in Section 1-102, and the mandate to the courts
to ‘liberally construe and apply’ the Code to further these policies.The policies stated in Article 1 create a
macro framework through which to process all of the Uniform Commercial Code.These blend with the policies of a particular
Article in the interpretation process. Supplemental rules of law under Section
1-103(b) is another section which allows facts to be uniquely applied to the
supplemental area of law which applies to the case.For those of you seeking to learn Article 2,
it would be helpful to review the earlier posts on Article 1, followed by the
Article 2 posts.The more thorough your
knowledge of Article 1, the better your foundation for everything that follows.

As we go forward
with Article 2, several things should be stated.First—and this is my opinion—sales
transactions are the least formalized transactions under the Uniform Commercial
Code.By that I mean it is less likely
that there will be a finalized, integrated document which has been formally
executed than in any of the other Articles.Sales transactions often involve a phone call, some correspondence, a
shipping document and conduct which recognizes the existence of the
contract.As a result, terms supplied by
the Code have greater significance.

Second, the
Article 2 expectation is that in the event of a dispute the parties will work
it out through negotiation.This is a
reflection of how these matters are handled in reality, and is reflected in the
general structure and content of Article 2. Hence, comment 4 to Section 2-607,
which deals with a buyer’s duty to notify a seller of a breach with respect to
accepted goods states:

The notification which saves the buyer’s rights
under this Article need only be such as informs the seller that the transaction
is claimed to involve a breach, and thus opens the way for normal settlement
through negotiation.

The ‘looseness’ of Article 2 in this regard
is to be contrasted with the specificity of other Articles. Under Article 9,
for example, you are more likely to find a definitive answer to a problem than
you would under Article 2.Secured
lenders want certainty when enforcement of a secured obligation must take
place.Thus, the policy of certainty is
expressed in the text of Article 9 and the policy of ‘keep the deal alive’ is
expressed in the structure and text of Article 2.

Third,
the definitions of ‘contract’ and ‘agreement’ as defined under Article 1 have
particular significance under Article 2.This follows from the lack of formality referred to above.Thus, course of performance, course of
dealing and usage of trade need to be carefully examined in each instance to
see how a particular concept might impact the contract.As noted in an earlier post, a particular
transaction may not involve a ‘course of performance’ or ‘course of dealing’
since parties may be dealing with one and other for the first time, and the
contract may not call for ‘repeated occasions for performance’ with
objectionable behavior.However,
virtually all sales transactions occur within some trade or industry which has
its own rules and protocols.Absent
limiting contract provisions, these rules and protocols become part of the
contract. Trade journals are a potential source of incredibly valuable
information.

Part 3 of Article 2 deals with General
Obligations of the Parties: Among other
things, Part 3 supplies certain terms that the parties may not have included in
their written agreement or writings.For
example, in certain circumstances parties to a contract can conclude a binding
deal without have explicitly agreed on a price; the Code will supply a place of
delivery if none has been stated; and where action is required by no timeline
stated, the Code requires that action be taken within a ‘reasonable time’.This ties into a Section 2-204(3) discussed
in an earlier post:

A contract does not fail for indefiniteness if the
parties intended a contract and there is a reasonably certain basis for giving
an appropriate remedy.

Section 2-301
states the obligations of the buyer and seller in very general terms:

The obligation of the seller is to transfer and
deliver and that of the buyer is to accept
and pay in accordance with the contract.

The
comment to Section 2-301 explains this as follows:

In order to determine what is in ‘accordance with
the contract’ under this Article usage of trade, course of dealing and
performance, and the general background of circumstances must be given due
consideration in conjunction with the lay meaning of the words used to define
the scope of the conditions and duties.

Section 2-301 thus forms the foundation for
going forward in litigation; implicitly emphasizes the importance of drafting;
and explicitly recognizes ‘usage of trade, course of dealing and performance’
as critical elements in determining the terms and interpretation of a
contract.These concepts, the drafting
style of Article 2, and the overall purposes and policies of the Code should be
incorporated in the process of analyzing Article 2 transactions.

Thursday, May 5, 2016

In the previous post we looked at
situations where ‘reasonable grounds for insecurity’ concerning the other
party’s performance have arisen, as well as action which can be taken in such a
situation to ‘demand adequate assurance of performance.’ The first sentence of
Section 2-609(1) notes in this regard‘A contract for sale imposes an obligation on each party that
the other's expectation of receiving due performance will not be impaired.' The
impairment contemplated by Section 2-609 is the result of some behavior by one
of the contracting parties.

Section
2-615 also contemplates a situation where performance is not forthcoming;
however, in this instance, the non performance is not caused by the behaviors
of one of the parties to the transaction.Rather, the non performance (or partial performance) contemplated by
Section 2-615 is the result of some event which makes performance
‘impracticable.'Section 2-615(1)(a)
reads as follows:

Except so far as a seller may have assumed a greater
obligation and subject to the preceding section on substituted performance:

(a) Delay in delivery or non-delivery in whole or in part by
a seller who complies with paragraphs (b) and
(c) is not a breach of his duty under a contract for sale if performance as agreed has been
made impracticable by the occurrence of a contingency the non-occurrence of
which was a basic assumption on which the contract was made or by compliance in good faith with any applicable foreign or
domestic governmental regulation or order whether or not it later proves to be
invalid.

In order for the event to come within Section 2-615, it must
be of such a nature that the non occurrence of that event was ‘a basic
assumption on which the contract was made.'

The other situation contemplated by
Section 2-615 is where the party who is unable to perform is precluded from
performance by ‘any applicable foreign or domestic governmental regulation.' As
noted in the text, it is irrelevant if the regulation is later proved to be
invalid.

There are
several things which should be noted in the initial discussion of Section
2-615..First, Section 2-615 deals with
a situation where performance has become ‘impracticable.'This is not the same thing as ‘impossible.'As noted in Official Comment 3 to Section
2-615, the word ‘impracticable’ was used ‘to
call attention to the commercial character of the criterion chosen by this
Article.'Second, although the
section is drafted as pertaining only to the seller, Official Comment 9 states
in part that in certain situations ‘the reason of the present section may well
apply and entitle the buyer to the exemption.' There is case law which supports
that result.Third, a dramatic price
change is not within the purview of Section 2-615.That stated, there must have been some event
that caused the dramatic price change, and that is where the focus should be
directed.

In order to avail oneself of
Section 2-615(1) the party must comply with Sections 2-615(a)&(b). Section
2-615(b) is activated when the triggering event affects only part of a seller’s
capacity to perform and requires an allocation of product by the seller:

Where the causes mentioned in paragraph (a) affect only a
part of the seller's capacity to perform, he must
allocate production and deliveries among his customers but may at his option
include regular customers not then under contract as well as his own
requirements in any manner which is fair and reasonable.

Note, upon activation of Section 2-615(1), the seller ‘at
his option’ may include ‘regular customers not then under contract’, and may
also include its own requirements for further manufacture.

Any allocation must be done in a
‘fair and reasonable manner.'Once
again, we see an opportunity to draft what is, or is not, an allocation which
is fair and reasonable, and if this is done, the inquiry will be limited to:
were the called for standards of ‘fair and reasonable’ met; and if so, were
these standards not ‘manifestly unreasonable’ per Section 1-302.As will be demonstrated shortly, this is one
of several creative drafting provisions that can pay big dividends in the event
of litigation.

Section
2-615(c) states the final requirement for Section 2-615(a) to be properly
utilized:

The seller must notify the buyer seasonably that there will be delay
or non-delivery and, when allocation is required under paragraph (b), of the
estimated quota thus made available for the buyer.

The procedure required for the notice referred to is
contained in Section 2-616(1)(a)(b)(2)(3).*

The general
freedom of contract principle contained in Section 1-302 is explicitly stated
in the first sentence of Section 2-615(a) which states in relevant part as
follows : Except so far
as a seller may have assumed a greater
obligation...
The ‘greater obligation’ does not need to be stated as guarantee of delivery in
a Section 2-615 situation.The greater
obligation can be created through a remedial provision.

Gold
Kist v Stokes138 Ga. App. 482
(1976),226 S.E.2d 268 involved
an appeal from a summary judgment.There
were a number of evidentiary issues at the trial court which the appellate
court required to be heard by a jury.Another issue raised was the failure of the trial court to include the
introductory language of Section 2-615 in its jury instruction as it relates to
‘seller assuming a greater obligation’.The contract in the Gold Kist case had the following provision:

... [i]f the
producer is unable to deliver the quantity contracted for solely because of reasons
beyond his control, the measure of damages for failure to deliver is the
difference between contract and market price on the day of breach.

In reversing the trial court, the appellate court found that
under the noted provision, seller had ‘assumed a greater obligation’ via the
damage provision, and that the failure of the jury instruction to include the
introductory language of Section 2-615 as it pertained to the assumption of a
greater obligation by the seller was error.

The case
graphically illustrates a point made throughout these posts. Proper drafting
yields great results.The remedial
provision probably got very little notice by the seller during negotiations or
one would assume the seller’s attorney would have objected to the provision.As a result of inclusion in the contract, the
remedial provision effectively overrode the result that would have occurred
under Section 2-615.

*(1) Where thebuyerreceives notification of a material
or indefinite delay or an allocation justified under the preceding section he
may by written notification to theselleras to any delivery concerned, and
where the prospective deficiency substantially impairs the value of the wholecontractunder the provisions of this Article
relating to breach of installment contracts (Section2-612), then also as to the whole,

(a) terminate and thereby discharge any unexecuted portion of thecontract; or

(b) modify thecontractby
agreeing to take his available quota in substitution.

(2) If afterreceiptof such notification from thesellerthebuyerfails so to modify thecontract within a reasonable time not
exceeding thirty days the contract lapses with respect to any deliveries
affected.

(3) The provisions of this section may
not be negated byagreementexcept in so far as theseller has assumed a greater obligation
under the preceding sections.

Thursday, April 21, 2016

Section
2-609 contemplates a situation where either party to a sales contract has
‘reasonable grounds for insecurity’ regarding the other party’s performance,
and the insecure party wants some evidence that the other party is willing and
able to perform. Subsection (1) to Section 2-609 states as follows:

The
cases are clear that the determination of whether or not a party’s stated
grounds for insecurity are reasonable is a question of fact. In this regard, I
want to emphasize a point made repeatedly throughout these posts, and
particularly in connection with the discussion of Section 1-302(b) which allows
parties to an agreement to set standards for what is or is not ‘reasonable’,
provided the standards set are not ‘manifestly unreasonable’.If standards for ‘reasonableness’ are in fact
stated, the inquiry will be limited to: were the called for standards met, and
if so, were the standards ‘manifestly unreasonable’? If the standards are not
manifestly unreasonable, and proven, inquiry ends. Parties to a contract, can
if they choose, create provisions for what ‘reasonably constitutes’ insecurity
which would frame the inquiry as stated.

A contract
for sale imposes an obligation on each party that the other's expectation
of receiving due performance will not be impaired. When reasonable grounds for
insecurity arise with respect to the performance of either party the other may
in writing demand adequate assurance of due performance and until he receives
such assurance may if commercially reasonable suspend any performance for which
he has not already received the agreed return.

Although there are some
cases which state that an oral demand for ‘adequate assurance of due
performance’ is sufficient, the majority of cases follow the clear language of
the statute which requires that the request for adequate assurances be in
writing. Further, the cases are clear that the writing which purportedly seeks
adequate assurances actually make it clear in the writing that such a demand is
being made.Mere objections as to
performance do not meet the standard of a demand for proper performance which
is required to gain the benefit of the provisions of the section. As discussed
in the last post regarding Section 2-607(5)(a), the best way to insure that the
requirements of a particular provision are complied with is to track the
language of the statute.

In Alaska Pacific Trading Company v Eagon Forest Products 85 Wn App 354, 93 P 2d 41 (1997) one of the issues considered by the
court was whether the purported demand for assurances was properly stated.The case involved a sales contract by which ALPAC
was to sell 15,000 cubic meters of logs to Eagon.The lumber was to be shipped from Argentina
to Korea.Between the time of the
execution of the contract in April of 1993 and time stated time for shipment,
the market price for the lumber dropped significantly. Eagon became tentative
about performing under the contract and ultimately, ALPAC came to the
conclusion that Eagan was not going to accept the logs, and decided not to
ship. In discussing whether or not a proper demand for adequate assurance of
performance had been made by ALPAC, the court stated:

Here,
while Ahn [Eagon] had some idea that Kimura and ALPAC were concerned about the
status of the contract, he did not understand that ALPAC would withhold
performance as a result….If we were to hold that, in every case where a
contract becomes less favorable for one party, general discussions between the
parties can be considered requests for assurances, we would defeat the purpose
of 2-609. That section requires a clear demand so that all parties are aware
that, absent assurances, the demanding party will withhold performance. An
ambiguous communication is not sufficient. Eagon at 357

When merchants are involved,
the determination of whether or not a particular performance was such as to
properly give rise to insecurity will be determined by commercial standards:

(2) Between
merchants the reasonableness of grounds for insecurity and the adequacy of
any assurance offered shall be determined according to commercial standards.

This is consistent with Article 2 in general
and the drafters’ consistent direction to focus on what is going on in the
commercial world, not simply the legalese involved.As stated in comment 2 to Section 2-202:

[This section definitely rejects] the premise that
the language used has the meaning
attributable to such language by rules of construction existing in law rather
than the meaning which arises out of the commercial context in which it was
used;

This policy applies throughout Article 2 and,
through the expanded definition of good faith, arguably throughout the Code.

Once
a proper demand for adequate assurance of performance has been made, the
failure to provide that assurance is a repudiation of the contract:

After receipt of a
justified demand failure to provide within a reasonable time not exceeding
thirty days such assurance of due performance as is adequate under the
circumstances of the particular case is a repudiation of the contract.Section 2-609(4)

Section
2-609 provides parties with a remedial type course of action which is short of
litigation, but clearly creates a situation where insecurities about
performance are either effectively dealt with through adequate assurances of
performance or repudiation occurs as a result of not providing those assurances.Firms dealing in sales and leases of goods
would be well advised to create a template for properly activating and
utilizing Section 2-609.This is in
addition to drafting a contract provision which sets standards for ‘reasonable
grounds for insecurity.'